9/09/2010 @ 3:00PM

High-Fee Passive Advisor Hypocrisy

hyp·o·crite [hip-uh-krit] – noun – A person who pretends to have virtues, moral or religious beliefs, principles, etc., that he or she does not actually possess, esp. a person whose actions belie stated beliefs. (Dictionary.com)

There are probably 20,000 or so registered fee-only advisors who manage portfolios for individual investors. Perhaps 3,000 advisors in the group follow a passive low-cost index fund strategy. These advisors preach the virtues of index investing such as low fees, low taxes and less risk.

The passive advisors are right! Index fund investing is a better choice. Of course, that’s assuming you buy the right index funds and ETFs in the right amounts, and don’t pay an arm and a leg to an advisor for portfolio advice and management services.

Unfortunately, many passive advisors talk the talk but don’t walk the walk. They preach low-cost, but it doesn’t apply to their own advisor fee. Many passive advisors will berate the brokerage industry and the fund companies for charging high fees, and then stick their clients with the same high fees for investment advice and portfolio management! That’s not what a true believer in passive investing would do. It’s what a hypocrite would do.

Allan Roth on MoneyWatch.com asked one well-known advisor to provide an explanation of the high fees his firm charges clients for managing portfolios. Ric Edelman embraced low-cost index investing a few years ago but has never applied the low-fee concept to his advisory firm. According to the Edelman Financial website, a $1 million account costs his clients 1.3% annually, which is $13,000 per year, not including fund expenses or trading costs.

Edelman explained to Roth that the fee also covers financial planning issues such as mortgage advice and whether to roll money into a Roth IRA. I’m all for providing this advice, but linking that advice to a 1.3% advisor fee is very steep. My firm also provides general personal finance advice and portfolio management for a 0.25% annual, which is $2,500 on a $1 million account. So, what’s with Edelman’s $13,000 fee?

Apparently, it’s the price that people are willing to pay to be with Edelman because they must believe that he’s that good. And maybe he is to some people. In my opinion, Edelman is charging what the market will bear, not what’s fair. A fair fee for servicing a $1 million client should be no more than $5,000 annually, which is 0.50%, and that includes basic personal finance advice. Anything more is making the advisor very, very wealthy.

High-fee passive advisors don’t like it when I bring up their fee mismatch, and will do what they can to stop me from exposing this issue. Here’s an example: I was recently kicked out of an online advisor group for pushing the issue of high advisor fees.

Linkedin.com is a website for managing business contacts. Groups can be formed online by members who have like interests. One group I joined was “Passive Investment Professionals”. Its members are supposed to be advisors who believe in low-cost investing and transparency of fees.

Out of curiosity, I checked websites of group members to get an idea of their advisor fees. The results were embarrassing to the community. Many of these so-called passive experts don’t eat their own cooking. Several group members hide their fees from the public, and many others are charging clients 1%, 1.5% and even 2% per year for advisor services. To make matters worse, these fees don’t include mutual fund expenses or commissions that their clients pay to trade securities.

I decided to start an online discussion with these high-fee Passive Investment Professionals to understand their reasoning for the high fee. As you may imagine, this discussion didn’t go very well. Think of what a room full of Paris Hiltons would say if asked to enter a convent. All were against me except one true low-fee advisor, Derek Tinnin of Purpose Wealth Management, who took my side in the discussion.

“I charge what the market will bear,” stated one high-fee respondent. Another wrote, “I provide a unique life- planning experience” that’s worth every penny. The first answer is more honest, direct and believable. The advisor stated he is going to charge the highest fee that people are willing to pay. This is what Edelman does also. The fee may not be fair, but that’s what the market will bear, so that’s what it is. I’m glad John Bogle didn’t have that attitude when he started Vanguard.

The second response was really a bit over-the-top for me. I’m not a touchy-feely type, so I don’t really understand what a “unique life planning experience” is or what that’s worth. But, whatever it is and whatever it cost, I suspect it’s not something that a person needs every year. So, why are clients being charged the same high fee every year by the advisor? I asked this question.

Within a day, I was kicked out of the “Passive Investment Professionals” group and all my posts were deleted. The group leader then wrote on the forum that “members who are destructive will be removed.” They hated my ideas about lower advisor fees so much that I was deemed unfit to be in their little circle. That’s hypocrisy in action!

John Bogle spent his life advocating low mutual fund fees and better ethics in the fund industry and is an icon for that reason. Now it’s the advisor industry’s turn to face the music. High-fee advisors are the last bastion of gluttony in the investment industry. My peers can kick me out of their club for pointing out that their Emperor has no clothes, but that just gives me more motivation to expose the truth.

Richard A. Ferri, C.F.A., is the founder of Portfolio Solutions, LLC, a low-cost investment advisor firm in Troy, Mich. He has written numerous books on subjects ranging from asset allocation to index funds and ETFs. He writes a blog at Forbes, here.